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MASTER OF HOODWINK: ESG NORMS

[Divya Telang is a fourth-year student at National Law University, Jodhpur]


Introduction


Environmental, Social and Governance [ESG] norms as a concept gained prominence in the 2000s, primarily in the west, and eventually seeped its way into India. It evolved as a tool that would allow investors to identify sustainability risks that could impact the businesses thereby allowing them to invest in companies that align with their values. However, it only paints an illusion of socially responsible companies, being environmentally friendly, having discrimination-free governance policies, who are contributing to society. For some reason ESG is believed to bring in better returns for investors, and is sustainable as well. Such a level of trickery, lasting for years, would have impressed Houdini who could only fool a group of people for a few hours into believing in magic. However, the ESG norms are a well-packaged scam wrapped with smart marketing and decorated with ribbons of limitations, such as having inconsistent weights and measures, lack of oversight and being prone to abuse by corporations.


Milton Friedman in an essay had stated that a company’s social responsibility is to make profit. An executive must aim to give its shareholders the highest return possible. Those who want to do social good must do so in their own time and with their own money. The heart of the quote is separating profit and planet from each other. One can support the planet however they want to, but expecting corporations to do the same is not practical. Corporations will not care, unless external factors force them to care. Only when their profit is affected, will they take efforts to change.


1. Show not do:


Socially conscious investors don’t want their returns to be the consequence of immoral and irresponsible business methods that do not take ESG factors into account. However, the ESG mechanism suffers from showmanship. There is the intention to do good but no implementation and action. Companies may cover their business model weaknesses through putting forth a persona of sustainability and goal for social welfare. For example, in 2015, the Coca- cola company stated it had achieved its goal of being “water-neutral” with the help of alliances with NGOs. It assisted 100 countries to preserve and replenish their regional watersheds which it was using for production, cooling and distribution. As a result, it received an AA rating from Morgan Stanley Capital International [MSCI]- a ESG rating system in the US. However, it did not include 90% of its water used in its agriculture supply for irrigating fields of sugar grown for its product. Thus, it created an illusion for the investors of being ‘water-neutral’, when in reality the majority of water consumption was unaffected. Due to the rating, it gave investors the perception that the company has good ESG practice. This shows, ESG index was not able to give a real picture of Coca-Cola’s ESG initiatives and it lacks in measuring a company's sustainability efforts, as it takes disclosures made by companies at face-value.


The MSCI rating system, includes corporate behaviour, employment practices, data protection and even structure of boards, as upgrading factors for better outcome for shareholders. Among the 155 factors, only one is relating to reduction in carbon emissions as a significant factor for an upgrade in rating. So, the rating system and the ratings themselves are the opposite of what investors believe they are looking at when they see a company which is rated high. They believe that the company has strong environmental and governance practices, when the opposite is actually being measured, that is, ‘whether the company attempts to be sustainable?’ So, even the ratings are corporate focused rather than environment focused. The same can occur in India where companies under the garb of being sustainable are actually doing the bare minimum. If this is the case, the point of introducing the ESG norms is useless.


2. Faulty Rating System:


As with any rating system, companies with a good rating are able to attract more investors than those with a lower rating. ESG ratings are based on how the environment may impact the company and not the other way around. ESG is a metric that provides the companies the blueprint for what is the minimum requirement so that they won’t come under the radar. ESG Indexes are not streamlined and vary from each other. As it is difficult to measure what qualifies as “goodness”, standardisation is subjective. The task of measuring something subjective which will then be referred to by investors and corporate managers for making a decision is not reliable. Having no consistency, and lack of transparency about what weight is assigned to which measure makes it difficult to evaluate the performance of companies and the associated risks of investing. With different standards, there is no uniform baseline or regulation. This makes it difficult to verify the company’s performance. For instance, in the USA, political influence plays a role. S&P Global removed Tesla from its ESG rating after Elon’s proposal to buy Twitter when on the other hand, an oil company- ExxonMobil with questionable ESG practices remains on the list. There is no guarantee that the same can be avoided in India.


There needs to be sufficient oversight in place, taking into account other factors apart from disclosures made by the companies that balances the needs of all stakeholders. Such as, a regulatory body to oversee the assertions and ensure that reports are complete and removing the variance in different rating indexes which confuses the investors and companies as well about what is valued and focused on in the evaluation. This can be done by having uniform scope which are measured with the same data and weighted equally, by all the rating agencies. There must be measures to prevent any external groups that could interfere in the rating authority’s work or have the influence to be a rating authority itself. This will motivate corporations and increase its credibility as an investment tool.


3. Feasibility:


India is the world’s fourth largest carbon emitter, accounting for 4.5% of greenhouse gas emissions. Even while Indian businesses may now be aware of and responding to ESG issues, they still require work to improve their financial reporting and corporate governance. ESG is a best-in-class metric, meaning the companies who have a good score compared to their peers. This means investors are not investing in companies which are completely ESG compliant, but those who are in the lead compared to others. Until there is standardization and ethical regulation, the ESG metric will not be beneficial for the country.


If the ESG system is placed there will be an incentive for companies to be ESG compliant in order to get more capital allocated to that sector, without actually protecting the environment as ESG norms only see whether the company is trying to be sustainable. With a bad rating system and absence of actual ESG sustainable actions, the companies are not really bringing any change. In addition, if ESG becomes prominent, capital can be cut off from other companies which are not compliant with ESG which is a non-financial rating system that can be easily manipulated and isn’t reliable.


India already has Corporate Social Responsibility, and Business Responsibility and Sustainability Reporting [BRSR] in place. These can be enhanced by inculcating the metrics that can be used to check ESG compliance as well. The implementation of SEBI’s Consultation Paper [Paper] is yet to be seen. Further, the Paper is providing 15 ESG metrics which fit the Indian context, and proposing customised rating on specific sectors based on user needs. This will assist in providing a clearer picture for investors. Lastly, disclosures of the supply chain which were voluntary under BRSR, will be made mandatory for companies on a ‘comply or explain’ basis. This will assist in showing a wider picture, as they will indicate the wastages, emissions, etc. in the supply chain. Though the Paper has stated that Rating will be provided based on disclosures, which are verified, how the verification is to be done has not been decided.


However, in a country like India which has a large number of new and young investors, they might prefer profit over sustainability. So, they might not consider ESG before investing. In order to reap the hype of ESG at its nascent stage, some companies may give misleading claims of being environmentally responsible leading to ‘greenwashing’. The Paper has suggested methods to mitigate greenwashing by mandatory disclosure assurance in the BRSR Core for the top 250 companies. To mitigate greenwashing risks at the scheme level, it is proposed that an ESG scheme should invest at least 65% of its Assets Under Management in companies reporting on comprehensive BRSR and providing assurance on BRSR Core disclosures. The remaining investments can be in companies reporting on BRSR. Mutual funds are already seeing an interest in ESG funds. Also, foreign investors and organisations like the World Bank might look at the ESG compliance prior to investing or providing a loan. Although the SEBI Consultation Paper is a step in the right direction, it is all conjecture unless results are seen.


4. Conclusion:


ESG is widely promoted as being advantageous for businesses, investors and society at large. However, the excitement about ESG far outpaces the truth regarding its reality and what it can actually do. In the end, a lot of money will be spent where a small number of people- consultants and ESG experts will have benefitted, but the companies will not be any more socially responsible than before the introduction of ESG norms. Fighting climate change by substituting public policies with corporate measures is not possible as in the end the company is concerned with its profit. Another ESG rating is not the right path to advance world sustainability. ESG may assist investors to measure risk and predict returns but it cannot actually achieve the goals it states to address. What is needed is to get rid of the belief that corporations have the ability to bring a huge change. Change through corporate can only be done through imposition by laws and regulation. Making the disclosures mandatory through the pre-existing BRSR Core will assist in the ESG Rating as well. In order to achieve sustainability and fair governance in India, what is needed is setting strict boundaries for capitalism, punishing violators of environmental health and using innovation and public welfare measures to counter global challenges.

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